CHICAGO -- Bond issuers that dictate who underwriters should hire as underwriter's counsel may have to disclose that information to investors if the counsel has given a political contribution to the issuer, a top SEC official said Friday.

"You're walking right into the question of whether it's material" information that should be disclosed to investors, Robert Colby, the Securities and Exchange Commission's deputy director of market regulation, said at a conference here on disclosure co-sponsored by Prentice Hall Law & Business and the Fordham University School of Law.

"It might be a disclosure item, yes," said Colby, who was fielding questions during a panel session on the SEC's new legal interpretation and proposed rules on municipal disclosure that were issued by the agency March 9. Comments on the initiatives are due July 15.

Colby said, however, that if there are other reasons why the issuer called for a specific underwriter's counsel, such a family connection or a lawyer being in the same town, it may not have to be disclosed.

"I don't think that's currently required by the antifraud provisions or by broker disclosure," Colby said. "If there's not some conflict of interest that's built in, if it's just a choice for some other reason," then there would not be a problem, said Colby, who was responding to a question posed by panelist Robert A. Fippinger, a partner with Orrick, Herrington & Sutcliffe in New York.

Fippinger said that one way to deal with the problem is to disclose in the official statement that the underwriter's counsel gave a political contribution to an official for the issuer.

But since issuers are unlikely to make such an admission, a more likely option is for underwriters to have the work of the underwriter's counsel reviewed by in-house counsel or by a general counsel retained by the firm, Fippinger said.

SEC member Richard Roberts also spelled out later during Friday's conference some of the top issues that have emerged from the SEC's proposed rule and interpretive release on disclosure.

For instance, Roberts said, dealers are concerned about a provision in the proposed rule that would bar dealers from recommending a security to a customer unless they have reviewed the secondary market information made available by the issuer.

But he gave no indication whether the commission will back down from the basic concept outlined in the rule.

"While I recognize that this particular proposal is very controversial, it would implement the long-held position of the commission and the self-regulatory organizations that dealers should make suitable recommendations based on their knowledge of the product," Roberts said.

The amendments would help dealers meet their obligations under the antifraud provisions by requiring that they review certain information made available by the issuer, he said.

Roberts added that the proposal does give dealers flexibility in how to meet the rule. Dealers are not required to actually "obtain" the issuer's documents before making a recommendation, he said. They can review the issuer's information in any way they see fit, he said.

Roberts welcomed suggestions on how to implement the concept "in the most effective, workable, and least disruptive manner."

He said he has been asked what incentive an issuer would have to provide secondary market disclosure, especially small localities. While Roberts said that in many instances, small and infrequent issuers would qualify for exemptions from the rule, the fact that dealers would not be able to continue to recommend their bonds might provide sufficient incentive for them to provide disclosure.

Finally, issuers that fail to provide disclosure may find themselves subject either to an SEC enforcement action or a private lawsuit brought by an investor, he said.

Roberts said the question of who is considered a "significant obligor" is another area of concern in the rules. The definition is important because the rule calls for information on any private entity responsible for 20% or more of the cash flow servicing the debt.

There has to be some connection, or participation in, the financing by the significant obligor, but it does not have to be a "direct linkage" between the significant obligor and the financing, Roberts said.

"Absent circumstances linking them to the financing, a significant customer or a taxpayer does not appear to me to fall within the scope of the proposed definition," he said.

Roberts said that another issue is which party, the significant obligor or the issuer, should provide the information on the private entity. He noted that the SEC's current disclosure Rule 15c2-12 already says that the definition of an issuer includes any issuer of a "separate security as well."

That means that any significant obligor whose participation causes it to be considered an issuer would be responsible for providing information, he said.

It also could depend on the contractual arrangement between the municipal issuer and the private enterprise, Roberts said, noting that "it seems to me that the ultimate responsibility should remain with the municipal issuer, even when that issuer is a conduit authority with no other resources."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.